Abenomics Outlook: Ya Gotta Believe

Japan’s big new economic stimulus program has had a remarkably effective launch. But despite the bold talk of “regime change,” officials still suffer from “a lack of credibility” about their determination and ability to end two decades of decline — and that in turn is still muting the impact of their actions, two American economists conclude in a new comprehensive study of Tokyo’s bid to end two decades of decline.

Bank of Japan Gov. Haruhiko Kuroda.

Bloomberg News

Japan’s next big challenge: to create a kind of virtuous cycle of confidence and success, in which investors and economists come to believe policymakers really can accomplish their goals, a belief that would in turn trigger the type of market reactions that would make success more likely. If officials “manage to convince the public… this will likely further stimulate the economy,” write Joshua K. Hausman of the University of Michigan and Johannes F. Wieland of the University of California, San Diego, in a paper to be presented in Washington, D.C. Friday at the Brookings Institution.

While the study is titled “Abenomics: Preliminary Analysis and Outlook,” it’s less about Prime Minister Shinzo Abe than his handpicked Bank of Japan chief, Haruhiko Kuroda. The Abenomics platform famously consists of three planks: a massive injection of fresh money from the BOJ, big new public works spending, and structural reforms intended to fix inefficiencies stunting growth. But Messrs. Hausman and Wieland largely play down the significance of the latter two. They cite the BOJ as the source of the most “radical” change since Mr. Abe took office in late 2012, the biggest factor behind the Abenomics success to date, and the policy that has potential to trigger more growth – if it can become more “credible.”

The centerpiece of Mr. Kuroda’s crusade is a pledge to steer Japan’s economy to a 2% inflation rate by next year, following more than a decade of steadily falling prices. The study’s authors credit Mr. Kuroda with already having “ended deflation” by stoking in 2013 the biggest jump in the consumer price index in five years. But they use various measures to show that markets don’t believe he can really hit his 2% target in a sustainable way. One gauge shows “long-term inflation expectations” of an annual rate of 1.1%. They say that’s a full percentage point higher than it was before Abenomics – but just halfway to the Kuroda target.

The American economists blame the shortfall in expectations largely on the failure of Mr. Kuroda’s predecessors to deliver on similar promises. And that credibility gap has a cost. Messrs. Hausman and Wieland conclude that interest rates adjusted for inflation, or “real interest rates,” would fall further if inflation expectations were higher, lowering the cost of money and stimulating more economic activity. “Full credibility would double the decline in the real interest rate that has occurred thus far,” they conclude, a shift they say could add as much as 3.1% to Japan’s output by 2022.

Some economists in Japan worry that Mr. Kuroda’s massive monetary expansion carries massive risks: runaway inflation, a spike in interest rates, a destructive devaluation in the yen, a meltdown in the gargantuan market for Japanese government bonds. The authors dismiss those concerns saying “the costs are few or none, and the benefits…. potentially large.” They suggest the best way for Mr. Kuroda to win over the skeptics is double down with another dose. “Actions speak louder than words,” they write. “Further large-scale asset purchases could be beneficial,” they add, a reference to the large purchase of government bonds that has become the primary tool for the BOJ to inject money into the economy.

Indeed, many investors are betting on a new dose of monetary easing from Mr. Kuroda as soon as this spring, to help cushion the effects of the scheduled April 1 increase in the sales tax.

Messrs. Hausman and Wieland are scheduled to present their paper Friday The high-profile discussants invited to review their research are two prominent critics of an earlier generation of Japanese monetary policymaking: former Federal Reserve Chair Ben Bernanke and Princeton Nobel Laureate Paul Krugman.

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